Most investors may not realize it, but we've got access to far more retirement savings options than were offered just a generation earlier. The traditional IRA didn't exist until 1974, and 401(k) accounts weren't a thing until four years later. Roth retirement accounts only surfaced in 1997, and Roth 401(k) accounts weren't allowed until 2006.
In many regards, though, having so many choices can be a little overwhelming. What's the optimal usage of all these types of accounts?
The best widely applicable answer to the question is "it depends." I suspect most people are more like me than not, however, so my personal answer to the question might be something worth everyone thinking about.
Comparing and contrasting different types of retirement accounts
But first things first.
If you're not familiar with these different retirement accounts, they're not difficult to understand. Traditional IRAs (individual retirement accounts) are just retirement savings accounts you fund and manage on your own, whereas 401(k) plans are retirement savings accounts offered by employers to eligible employees. Any money deposited into both kinds of accounts is usually tax-deductible for the year in which the contribution is made. Withdrawals from these accounts later in life, however, are typically taxable as income.
Roth accounts are taxed differently. They don't offer any immediate tax benefit while you're funding them, but any money removed from these accounts later comes out without any taxable consequence. And, as is the case with their traditional counterparts, Roth 401(k) plans are available via an employer, while ordinary Roth IRAs are accounts you open with a brokerage firm, and then fund and manage on your own. Just know that higher earners typically aren't allowed to contribute to a Roth IRA, although they can still participate in a work-sponsored Roth 401(k). Be sure to check the IRS website for details on those income limitations.
Contribution limits differ between self-managed IRAs and 401(k) accounts, by the way. For tax year 2024, people under the age of 50 can only deposit up to $7,000 of their personal income into a traditional or Roth IRA, or up to $8,000 if you're 50 or older. These elective deferral limits swell to $23,000 for both types of 401(k) plans for last tax year, plus another $7,500 for anyone aged 50 and up. For tax year 2025 the ceiling rises to $23,500 for everyone, while the so-called "catch up" amount for the 50-and-over crowd is upped to $11,500. (Meanwhile, your employer can still contribute considerably more than these amounts on your behalf.)
But the question remains, which of these options do I personally prefer?
For me, it's all about minimizing taxes... whenever they're due
Cutting straight to the chase, my chief goal is minimizing my tax bill by reducing my taxable income as much as I can when my tax rates are at their highest. Conversely, I aim to incur as much of my eventual, inevitable taxable income as I can when my top marginal tax rate is at its lowest.
What does this mean in more practical terms? Since I believe I'm earning more now than I'll be earning in retirement (when I'm living on my accumulated savings), I'm funding tax-deductible vehicles as much as I can at this point in time; I'll risk paying an unknown tax rate on any future withdrawals, trusting that tax rates won't look too different than they do now. That's why I'm utilizing a traditional IRA account and the self-employment equivalent to a 401(k) much more often than I'm utilizing either kind of Roth retirement account, even though I've got the option of funding all four types of accounts.
That doesn't necessarily make it the right move for you. It's possible you've saved enough money -- and the investments in your retirement savings accounts have performed well enough -- that you end up with an even larger income once you're retired than you're earning in your working years. If that's the case, funding either or both kinds of Roth accounts probably makes more sense for you from this point forward (assuming you're able and eligible to do so).
I also fully intend to live on my retirement savings when the time comes. If you don't need or want any withdrawals from a retirement account in the future, know that Roth IRAs aren't subject to the required minimum distribution (RMD) rules that force you to take the taxable withdrawals from conventional IRAs and 401(k) accounts that I know I'll be taking.
Best of both worlds
With all of that being said, you should also know that I'm taking full advantage of the flexibility I have.
Whereas some employers will let you split your 401(k) contributions between pre-tax and post-tax income (effectively allowing you to simultaneously fund an ordinary and a Roth 401(k) account), the amount of these designations may or may not be easy to change from one paycheck to the next. But I can contribute to either -- or both -- in any given year. I don't have to decide until I'm filing my taxes by April of the following year how much I'm going to contribute to either.
I just can't contribute more than the total allowable limit to work-based retirement accounts. This flexibility allows me to lower my taxable income by a very precise figure in a good year, while in a not-so-great year I may go ahead and fund my Roth accounts anyway -- since I don't need the income tax deduction as much.
You may not have the same option with your work-sponsored 401(k), but you do have the same flexibility with an ordinary IRA and a Roth IRA. You can reduce your taxes now and pay them later by funding a traditional IRA, or you can forego the tax help now and take tax-free withdrawals later with a Roth.
Not the right detail to obsess over
Still don't know which option is best for you? You're not alone. Nobody can predict future tax rates or future tax brackets, or even future income. Again, though, I'm willing to bet taxes won't change much -- relatively speaking -- between now and then, just as I'm willing to bet that my retirement income will be less than I'm making now. Only time will tell if I'm right.
The good news is, none of this may matter too much in the end anyway. You will pay taxes at some point on this money. It's just a matter of when. If you're making the most of any tax savings achieved while you save for retirement and/or then making the most of any future withdrawals, you'll likely end up about as well off either way.
Your chief concern, therefore, should just be tucking away as much as you can regardless of the kind of account(s) you're using.
